Pay Down Debt Or Invest? Implement FS-DAIR

The decision to pay off debt or invest is a personal one that depends on a lot of factors: risk tolerance, your number of income streams, liquidity needs, family expenses, job security, investing acumen, retirement age, inflation forecasts, and bullishness about your future in general.

I’ve had hundreds of people ask me this question about paying down debt or invest over the years. As a result, I’ve racked my brain for months to figure out a viable Debt / Invest framework solution that can be used by many.

The solution I’ve come up with is called, “Financial Samurai’s DAIR” or “FS DAIR” for short. The idea is to come up with something easy to remember, challenging, logical, and effective, much like the 1/10th rule for car buying to help folks maximize their wealth. Even though plenty of people have objected to my 1/10th rule for being too restrictive, I strongly believe the rule has helped people minimize financial regret and boost the incredible feeling of progress and financial security.

Since we are all CFOs of our finances, we need to figure out the most efficient use of capital. My goal is to make personal finance simple so ACTION can be taken. All talk and no action leads to nothing. I’d like to “DAIR” you to follow my debt pay down rule to achieve financial freedom sooner, rather than later.

Basic Background Of Interest Rates And Returns

Stocks have historically returned as little as 1% in the 2000s to as high as 19.58% in the 1950s. The average since the 1900s is in the range of 6-9%. Debt, on the other hand, is a little more difficult to track. We know that the 10-year yield has come down from 14.5% in the mid 1980s to under 2.5% today, even after the Fed decided to start raising interest rates.

When times are good, you generally want to invest more money and leverage up. When times are bad, you want to reduce exposure to riskier investments and improve your financial security by paying down debt and raising cash.

Finance is very Yin Yang. Nothing happens in a vacuum. If income growth, the stock market, and inflation all start going ballistic, the Fed will raise interest rates more aggressively to contain inflation and stocks will fall, at least in the short run.

If we’re in a protracted bear market with falling stock prices, deflationary income and rising unemployment, the Fed will lower rates to stimulate the economy through more borrowing. This is exactly what the Fed did after the dotcom bubble burst in 2000, which lead to a rebound in the economy. Unfortunately, the Fed’s actions also created another bubble in housing. Using monetary policy to tweak the economy is not easy, but we’re getting more efficient at it.

You can view interest rates as a reflection of inflation. Tell me the interest rate on a savings account or CD comparable from any country, and I can tell you the country’s nominal interest rate within a couple percent. For example, a couple readers have commented that they are investing in 9% returning savings accounts in India. That’s an incredible return since savings interest rate in the US is still only around 0.1% – 0.5% and 5-year CD interest rates are under 2.5%.

The reason why Indian savings accounts are returning 9% a year is because nominal inflation is running at least 7% – 8% a year! The real return is therefore only 1% – 2%. There is no free lunch.

The real interest rate is calculated by simply subtracting the nominal interest rate by the nominal inflation rate. If you are getting a 100% raise a year, but all your costs are going up 100% a year, you’re swimming in place. This was the biggest complaint my Chongqing cab driver had during our hour long discussion from the airport to the hotel. His income was rising 30% a year, but food prices were rising 40%.

For more clarity, I argue why the best time to buy property is when you can afford to do so. Given property values are generally multiples higher than people’s incomes, property values will eventually become unaffordable for more and more people if income doesn’t grow much faster than property price inflation and/or if interest rates don’t come down enough.

For example, if a $1 million dollar property increases by 3% a year and your $100,000 a year income also increases by 3% a year (a common scenario in SF or NYC), you are actually falling behind by $27,000 a year! You have to increase your income by 30-% a year just to keep up!

If you can’t afford to buy your primary residence, then at least gain exposure to real estate through REITs and real estate crowdfunded investments around the country. I’ve personally invested $260,000 in real estate crowdfunding in 2017 to buy heartland real estate where valuations are cheaper and rental yields are much higher. My plan is to build a $500,000 position by 2020 as I diversify money away from expensive coastal real estate.

If you believe interest rates will be rising, then your existing debt becomes “more valuable.” For example, let’s say you are borrowing at 3%, but comparable loans rise to 10% in three years. The value of your debt to increases because other people would be willing to pay you more for the ability to borrow at 7% lower interest rates.

In terms of investing, if interest rates rise to 10% then your investments should aim to return a level of 10% or higher to compensate you for the risk you will take (equity risk premium). Otherwise, you can just lend out your capital, which entails its own risk.

If you believe interest rates will stay stagnant at these low levels or decline, then you should be more inclined to invest in equities, real estate crowdfunding, REITs, private equity, and more given the opportunity cost or hurdle rate to invest in equities has declined.

For example, let’s say the interest rate on a 5-year CD drops to 1% from 4%. 2.5% yielding stocks start looking more appealing now, and you should probably allocate more of your savings to such securities. An easy rule of thumb I use is to start asset allocating more into equities when the S&P 500 dividend yield is equal to or greater than the 10-year yield.

If any of these examples do not make sense, please let me know because understanding how interest, inflation, debt, and equity returns relate is very important. There won’t be a 1:1 correlation, but there definitely is a relationship over time.

The Financial Samurai Debt And Investment Ratio (FS-DAIR)

Now that you’ve got a basic understanding of the correlation between interest rates, inflation, and investment returns, I’d like to introduce a pretty dummy proof way to figure out how to allocate each dollar saved towards debt pay down or investments.

The percentage of one dollar you should consider allocating to paying down debt is simply the debt interest level X 10. In other words, if your debt interest level for your student loan or mortgage is 3%, then allocate 30% of your savings to pay down your debt, and 70% of your savings towards investments.

If you have a debt interest level of 10% or higher, then you should consider allocating 100% of your savings to paying off that debt. The only debt interest levels above 10% in this current interest rate environment are debts from loan sharks and credit card companies. You might also be consolidating your debts via P2P borrowing on a place like Prosper at 10% or more. But at least it’s less than the alternatives. If this is the case, focus on paying down your P2P debt as well.

I strongly believe that using the FS-DAIR is an effective and easy guideline to use when facing the debt and investment dilemma. FS-DAIR is not perfect, but it is formulated in a way that seeks to maximize the efficient use of your capital over time. While you are actively paying down debt and investing, you should also be religiously tracking your overall net worth with a free financial tool so you can measure your progress.

Some of you might be asking what to do if you have multiple debts? The simple answer is to stick to the highest debt interest rate and adjust the ratio for paying down debt after the highest interest rate debt is paid off.

Paying Off Multiple Debt Strategy Example:

1) 16% interest credit card debt for $10,000

2) 9% interest P2P loan to consolidate your higher debts for $20,000.

3) 2.50% student loan debt for $10,000 over 20 years.

Using FS-DAIR, you would allocate 100% of every dollar saved beyond your comfortable liquidity level (3 months minimum is my recommendation) until the 16% credit card debt is paid down. Then you would allocate 90% of your savings towards paying down your P2P loan debt and 10% to invest. Once the P2P loan debt is paid off, then allocate 25% of each dollar saved towards paying off your student loans. Of course you are welcome to also pay down the smallest absolute dollar value debt as well to keep motivation alive.

Paying Off Student Loans And Investing In 401k Example:

1) 3% student loan debt of $25,000

2) 5% company match on salary of 401k contribution

3) $65,000 gross salary, $35,000 expenses

Here’s an interesting scenario brought up by a reader. He’s wondering how does FS-DAIR work if he cannot afford to max out his 401k to $19,000 for 2019, but still wants to contribute and pay down debt. This is a tricky situation with no bad answers. My proposal is as follows:

1) Contribute at least 5% of gross salary to 401k to get 5% match e.g. contribute $3,250 and get another $3,250 for a total of $6,500. This way, no matter what happens he’s maximizing his returns.

3) Subtract net income of $43,225 to the realistic estimated expenses of $35,000 = $8,225.

4) Use 30% of $8,225 = $2,468 to pay down principal a year beyond the normal monthly payments.

5) Use 70% of $8,225 = $5,758 to invest in an equity index fund like SPY. He could and should just add $5,758 to his 401k contribution a year by contributing about $500 extra pre-tax to minimize his tax expenses. But at current income levels, he doesn’t have much in terms of a liquidity cushion, so it may be better to just invest $500 a month in an after tax instrument.

Note: Student loan interest is also generally deductible from your income too if your modified adjusted gross income (MAGI) is less than $75,000 ($155,000 if filing a joint return). The deduction can reduce the amount of your income subject to tax by up to $2,500 in. One day, the government will show equality for all.

Paying Off Mortgage Debt Example:

1) 5% 30-year fixed mortgage and no other debt

2) $100,000 gross income

You must calculate the real mortgage interest rate after deductions. If you are beyond the standard deduction levels and can’t figure out the exact deduction value, then a good estimate is to simply take your mortgage interest rate and multiply it by 100% minus your marginal tax rate, e.g. 5% mortgage X (100% – 33% marginal tax rate) = 3.35%. Use FS-DAIR again to allocate 33.5% of your savings to pay down your mortgage and 66.5% to invest. You can use the same framework above for contributing to a 401k.

If you have a $100,000 income or more, you should be able to max out your 401k. If not, continuously work your way up using FS-DAIR so that you do. And once you do max out your 401k, continue using FS-DAIR until all your debt is gone.

Mortgage rates continue to stay very low, which is why you should check the latest mortgage rates online to see if you can get an interest rate 0.5% or lower with a breakeven point of 18 months or less. The longer you plan to live in your home, the more worthwhile it is to refinance your mortgage.

So what happens when you reach 0% debt because you don’t have any debt left? The answer is simple. Enjoy life, throw yourself a party, continue building passive income streams, and make sure your money doesn’t run out!

Wealth Building Recommendation

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About the Author: Sam began investing his own money ever since he first opened a Charles Schwab brokerage account online in 1995. Sam loved investing so much that he decided to make a career out of investing by spending the next 13 years after college on Wall Street. During this time, Sam received his MBA from UC Berkeley with a focus on finance and real estate. He also became Series 7 and Series 63 registered. In 2012, Sam was able to retire at the age of 35 largely due to his investments that now generate over six figures a year in passive income. Sam now spends his time playing tennis, spending time with family, and writing online to help others achieve financial freedom.

Updated for 2019 and beyond. I’m slowly paying down mortgage debt with some gains I’ve made in the stock market and building a municipal bond portfolio now that rates have increased.

Author Bio: Sam started Financial Samurai in 2009 to help people achieve financial freedom sooner, rather than later. He spent 13 years working in investment banking, earned his MBA from UC Berkeley, and retired at age 34 in San Francisco.

Sam’s favorite free financial tool he’s been using since 2012 to manage his net worth is Personal Capital. Every quarter, Sam runs his investments through their free Retirement Planner and Investment Checkup tool to make sure he stays financially free, forever. It’s free and easy to use.

For investing opportunities in 2019, Sam is most interested in investing in the heartland of America through real estate crowdfunding. Property valuations are much cheaper and net rental yields are much higher. There is a demographic trend towards moving away from higher cost areas of the country to lower cost areas thanks to technology.

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Comments

I agree! Though I tend to use a more conservative market return of 8% so I think 8% interest would be my magic number but the difference between 8-10% is not much in the sense that if something is costing you 8%, then it likely is costing you 10% and it’s unlikely you’ll have something in between.

I hate carrying CC debt, even though my CC that I use is 0% for another few months, I hate seeing the balance on it and just throw money at it. Bad money management but at least I won’t accidentally pay interest when the time comes!

Jay,
If you hate carrying a cc balance then why do you do it? How much of a balance do you have and when do you plan on paying it off?

We use our CC cards extensively, between $5-15grand a month but always pay off in full two days before the bill is due. (Gotta get that .8% interest :) )

Once I thought we missed the cc date and it was the worst feeling ever. I got physically sick, stomach turning in a knot, headache, clammy skin, until I was able to get on a computer and check my payment and realized my partner paid it off on time. Have never missed a payment so I have no idea what happens but it felt like the second my payment was late I would be hit with >20% interest and the end of the world was nigh.

Jay,
If you hate carrying a cc balance then why do you do it? How much of a balance do you have and when do you plan on paying it off?

We use our CC cards extensively, between $5-15grand a month but always pay off in full two days before the bill is due. (Gotta get that .8% interest :) )

Once I thought we missed the cc date and it was the worst feeling ever. I got physically sick, stomach turning in a knot, headache, clammy skin, until I was able to get on a computer and check my payment and realized my partner paid it off on time. Have never missed a payment so I have no idea what happens but it felt like the second my payment was late I would be hit with >20% interest and the end of the world was nigh.

I still like to use debt to increase my cash flow and net worth by buying real estate. My only concern is that my bank will stop giving me mortgages; I have 11 now. I don’t have any cc debt or any debt above 5%.

Real estate is a fantastic way to beat inflation. When rents rise your mortgage payment stays the same. When values rise your mortgage amount stays the same. Since you can put less money down then the value of the house, rise in rent and value increase your returns much higher than than inflation.

Do you have to deal with deadbeat tenants with that much property? I’ve had few friends who tried being a landlord, but bailed after getting few bad tenants. I don’t have personal experience, but have read at least in SF, evicting a tenant is expensive and difficult.

This is something that I have been struggling with. I only have students loans left to pay with an interest rate of about 5.5% so based on your table I should be allocating 55% to the debt. I think this is pretty reasonable and straight forward. I was trying to pay off my student loan as soon as possible and not investing (on taxable accounts, I’m still contributing to my 401K and Roth IRA), but I’m going to reconsider and split it up.

Remember, that if you are below the annual income threshold your student interest is tax deductible. Therefore, according to Sam, your pay down amount would be less than that 55% that you’re assuming. It would mirror his example of a mortgage pay down where you would have to calculate your effective student loan interest rate, which would be about 1/3 lower. Of course that is only one factor to look at when it comes down to paying off student loans.

The other factor that everyone tends to ignore and I think should be addressed more regularly is the fact that student debt is not eliminated through bankruptcy. This factor alone should play a huge part in your decision to pay off your student loans early. As part of any financial planning, you’re allocating your assets in such a way as to protect your futures interests. Part of this planning should include a plan to protect yourself from a bad situation or a worst case scenario, this is why someone would establish an emergency fund. If you’re truly planning for a worst case scenario, you would have to assume that you will have to file for bankruptcy and start from scratch. If this is the case while you might lose the house that you bought, the car that your drive and all of the other nice things you bought on debt, you would start off with a blank slate and your debt would be gone. But in the case of student loans, you’ll now have a degree that will be fundamentally useless, try to get well-paying job that requires a college degree with a bad credit history, and you are still responsible for that student debt.

If you’re really looking out for your best interests, pay off that student loan as fast as you can.

Great point about student loan debt not YET being forgiven in bankruptcy. But it sounds like legislation is underway to have student debt forgiveness after 10 or 20 years, and capped at 10% of one’s annual income. What are your thoughts on this?

This is brilliant. There is such a huge market for debt reduction that you could probably turn DAIR into a completely trademarked financial franchise. Turn this post into a 30,000 word book and you’re off to the races. If I was you I would register debtdair.com immediately and keep it in your backpocket while mulling the idea.

I really don’t think it would be that hard to crank out a 20-40K word book on the matter. I would imagine that mining your existing data would render plenty of content. I’d be interested in skeletoning the content, perhaps even drafting. Sure, I could I build the site as well. I have some decent marketing ideas. Only question is, do you want to go full fledged Dave Ramsey, or is that too cheese dick and perhaps you’d prefer to just put your material out and what will be will be.

1) This is likely obvious, but even if your highest interest rate on debt is 10%+, I’d strongly argue that anyone who is offered a 401k match or similar incentive should take full advantage. If an employer is matching you dollar-for-dollar, your return is essentially 100%.

2) Even if you’re not getting an employer match, there’s a value in the tax deduction of your 401k contributions. I would factor this into my own personal decision between investing and paying off debt.

3) Student loan interest is also deductible for many, so take this into consideration when looking at your student loan interest rates.

Great reminder that student loan interest is deductible for some! I didn’t put it in because once again, the government implements discriminatory taxation policy that is not available to everyone. But let me add an annotation in the post now.

From the IRS:

“Generally, personal interest you pay, other than certain mortgage interest, is not deductible on your tax return. However, if your modified adjusted gross income (MAGI) is less than $75,000 ($155,000 if filing a joint return) there is a special deduction allowed for paying interest on a student loan (also known as an education loan) used for higher education. For most taxpayers, MAGI is the adjusted gross income as figured on their federal income tax return before subtracting any deduction for student loan interest. This deduction can reduce the amount of your income subject to tax by up to $2,500 in 2013.”

Sam, very interesting lean to your recent posts…very in-line with my thought process as well. Okay so here is the question for you: if you had a sudden windfall today of cash that was enough to erase exactly 100% of all your mortgage debt, would you write the check and be debt free?

So I can see how that would sort of shoot the premise of the FSDair in the foot paying it off early, so I good answer! As long as the end goal is eventually to be debt free it is a pretty good plan : )

In your specific situation consider paying off the mortgage. If you put down some of the windfall on a mortgage, but it does not pay it off, the monthly payment does not change. But if you are able to pay off the entire mortgage, it opens up your entire monthly payment as positive cash flow. The investment possibilities for all that cash are endless. Use the windfall to change your life, not just advance your net worth. Pay off the mortgage or invest it all, doing a little of both doesnt significantly change anything.

Paying off debt is good. Investing is good. Investing and paying of debt is good. I don’t see a downside to however you want to slice this pie.

I’ve been grappling with this issue ever since I graduated but I feel I’ve come to a good balance that is pretty close to DAIR. My highest student loan, which I’m currently trying to pay off, is at 6.5% and my next highest loan is at 4% so I will be able to free a good amount of money for investing once I get rid of the 6.5% loan. You’re definitely right that the need for liquidity comes into play as well. When me and my wife didn’t have a kid we could keep a good amount of money towards saving and investing but with a kid we need to be a little more liquid.

I have been able to deduct $2500 the last few years for student loan interest. Recently got a raise and doubled my student loan payment amount to get rid of them (interest rates range from 5.25 to 7.25%). Would rather be debt free and put the 1K plus a month into investments.

Still contribute to a 401K and Roth IRA (considering eliminating these contributions until my loans are gone after reading this blog the last few months)

I agree that the inclination is to invest and leverage up when times are good and reduce exposure and pay down debt when times are bad, but I’m trying my best to fight that inclination and do the opposite. It seems to be how real fortunes are made, at least in real estate.

I still disagree that the best time to buy property is when you can afford to do so. I think the best time to buy property is during a deep recession (but SF is a market I do not follow or understand, so you may be right in your market). You just have to beg and borrow wherever you can and then refinance if necessary when the market improves. I had a great mentor in an industry group who was the embodiment of stealth wealth (centa-millionaire who lives in a 4-bedroom house, drives a prius and sends his kids to public school – made his first million in technology then made the rest by buying real estate only during recessions and selling on the way up, then waiting patiently for the next cycle).

Very good analysis on the debt payment calculator. Thank you for including it.

I don’t have any debt other than 0% Barclay travel promotion debt and my mortgage. Your analysis makes much sense, but I prefer to just pay any debt off as long as I can maintain my 12 months liquid fund of expenses. Paying off a mortgage early on a single family home in the bay area isn’t that easy though unfortunately for most people.

Hi Sam,
First post, but started following your blog a few months ago and love the regular posts with my recent interest in finance, investing, and planning the long haul towards retirement (28, aiming for 50).

Love the concept of DAIR. I’ve been using a somewhat similar model, breaking down my extra pay between my car loan (1.9%), mortgage (3.75%), liquid savings, and long time equity investments, but not targeting the highest % first due to different loan terms and goals.

Anything above 10% in your model in my mind has to be CC debt, right? You would have to be insane to finance anything above 10% today. But I guess in the case of sub-prime, you may have people financing cars, etc. at 15-20+%, which is scary, but honestly they probably aren’t reading your blog, but they should!

Where I challenge or think the caveat for the DAIR is, if that >10% is for CC debt, with todays variety, you should be looking to transfer that debt to a 0% interest card for 18 months to save some money. Still allocate that 100% (or whatever necessary) of what you can towards paying it off to make sure that balance hits zero before full term.

Always good to have new readers. Anything above a 10% interest rate is credit card debt, P2P loans, or a loan shark, frankly.

But for P2P, if you borrow at 11% to consolidate 20% CC debt, that’s a win!

Transferring CC debt to a 0% interest card is a nice short-term solution. But I fear people will stay in the borrowing trap and never bother to pay it off. We need a good system to stay the course. FS-DAIR, I think is it!

Great post as always. Had a question that is semi-related to FS-DAIR, I have a triplex that I purchased a bit ago and the mortgage on it is my only debt at a very low rate. I don’t want to live at the property because I pay less in rent at my other job as a property manager than my triplex tenants do. Debt is being paid down with cash flow of the property.

My SO (will be wife soon) wants our own house or duplex badly, so we’ve been saving for the down payment on that. Question is, if it will take 3-4 years to save for the down on this theoretical house in question, what would you do with the saved cash in the meantime? Bond and CD yields are low but at least they’re safe. Hesitant to buy securities with it because of the potential loss. Any input would be appreciated, thanks!

Welcome to my site, and great question which I have a post on soon. The #1 thing now that you’ve earmarked the money for a purpose is Capital Preservation. The desire to make more returns from your earmarked capital should be tempered. I personally look at one year structured note products that have downside protection, and extra yields. https://www.financialsamurai.com/example-of-how-a-structured-note-works/

But CDs, and even online savings accounts for 0.5%-1% is fine b/c it’s all about preservation once again.

I know a couple in their mid 60’s with a 150k mortgage left on their house. They have a NW well into the millions but keep the mortgage because it’s only a little over 3% interest rate and because of tax deductions. An interesting perspective – they just have no desire to pay it off even though they could write a check tomorrow.

That is interesting they’d happily keep a $150K mortgage with a NW in the millions. I would think it’d feel like such a nuisance, since their deduction isn’t beyond the standard deduction at that level.

I disagree with you here Sam. If I can put my money into a Muni with a 5% CPN and collect that interest, why would I pay off my 3% mortgage? With mortgage rates being so low, it makes absolutely no sense to pay down debt. The correct response would be to take cheap $ as long as possible. Rates will eventually rise and when they do, my 3.5% 30yr mortgages will be looking pretty darn good.

Paying a penny more to the balance of the loan makes absolutely no sense.

With a 3% mortgage, investing 70% and paying down 30% is a prudent move because you just NEVER KNOW. And if you think you know, then you might have only lived through a recovery. How old are you? Hoping you’re older given you’re talking about bonds!

Just as an FYI all of my bond purchases are at or better than a 7% TEY. And once again, with the eventual 6%+ coupons I am protected against any move in interest rates.

I am only 30yrs old and am more then comfy earning a 7%+ TEY on my portfolio. My business partner who is 62 has used the same strategy for 30+ years and is worth a cool 30mm

I know you will try to blow holes in this strategy but to be honest I have been as objective as possible viewing this and not sure you can come close to a 7% TEY in this environment with any portfolio.

you are trying to be a man of too many hats here, munis are cheap and hybrid munis are a no-brainer

Ah, I’d love to be 30 years old and start investing when the stock market and bond market have only gone up every year since 2009. There’s nothing I can say to tell you that non risk-free assets do go down as well. You just have to experience it for yourself.

But I do think your response is indicative as to why everybody should be multi-millionaires at some point. It’s so easy to get rich nowadays and retire early. 6-7% compounded gets there quick. Now imagine if you are worth $30M at 40! Now that’s living good.

Just another little counter point to your about bonds “going down too”. What do you think is going to happen to real estate when interest rates go up?! Just an FYI the economy is still fragile and once we see a pop in interest rates, housing will get crushed.

I’ve seen enough as a fixed income professional to know where to put my money. The stock market is a certified Ponzi scheme and casino.

For some reason I can’t respond to your other posts, cannot see the reply feature on my phone.

Anyways I was trading equities during 08-09 and got a glimpse of how fast things start to drop. For that reason, I always keep some dry powder and currently have 50% of my bet worth in 5% front end munis that mature 2017-2019. And yes, I am earning 4-5% a year on 1-3 yr paper that is tax free. The TEY on this stuff is 8-10% depending maturity.

The other part is my portfolio which i call the “kids college fund” is locked up in longer zero coupons. If/when these back up, I will just buy more. The beautiful thing with zeros that most people don’t know is you can make $ and still take a loss.

I currently own my house, have a 3.5% 30yr and about 230k left on the 300k mortgage. If I wanted I could pay this off tomorrow, but earning 5% on my cash, tax free it doesn’t make sense to pay it down as I am
Picking up a 1.5% Arb.

I really like your Realtyshares idea and I have opened an account that I will be funding once I see how the deals react to a slower real estate market. I think we are at peak levels in US real estate and we will see 2010-2011 pricing again soon. The younger generation is not buying houses and I think that will create excellent opportunities in the next decade.

I like it! Systems are more effective than willpower when it comes to paying down debt. Better to have a clear plan than to try to gut it out over a long period of time. And the one you’ve created is flexible enough to account for opportunity costs, too.

The only debt we have is a 3.8% 30 year mortgage. I hadn’t planned on paying extra towards it because with our marginal tax rate (33%) we’re effectively paying less than 3% for that money.

It would feel a little wrong to divert 25% of our savings to this 30 year note. Not saying that it _is_ wrong, just that it feels weird. We are saving a lot each month, and 25% would be nearly the entire mortgage payment again.

Maybe I have more of an appetite for risk?

On the other hand, if someone straight up offered me a 3.8% loan that I could use to invest in the market… I don’t know if I’d take that. Especially with where valuations are currently.

This really provides food for thought. Thanks for making me look at my mortgage in a slightly different light! Still not sure if I’ll modify my strategy, but it’s always great to have my assumptions challenged!

The question is: What are you doing with your savings? If you are just keeping it in a money market account earning less than 1%, then it is a suboptimal use of your cash. Investing is a tricky one due to risk.

But since it seems like you only have one mortgage, and you feel it’s fine, then feel free to carry on!

Your DAIR table makes a lot of sense! With interest rates so low, you should not dedicate all your disposable funds to paying down debt. After all, you would miss out on a Bull market and time in your 401k. The amount of time your money is invested relates very strongly to your return.

IMHO I prefer to leverage down during good times as my pay/bonus is tied to the economy. Meaning if it’s hitting the fan, I have risk in my income. However, I make sure that I have a war chest available to take advantage of opportunities if they arise!

My advice is to truly understand where your income is derived from….as they should drive your strategy.

I love the FS-DAIR idea. pretty good rule of thumb. personally though i like leverage. Any rate less than 3% is a steal, anything less than 5% is ok, anything above it, i’d get rid asap. btw your 6 to 8% returns in the 1900s do not include dividends. Tack that in and it gets bump 8% to 12%. Also the best time to lever is when everyone else is scared because prices are low, brian says the troof. In any case, RESPECT.

I think this is a great ‘beta’ draft of this concept, and something I’ve been wrestling with myself lately.

One thing the ‘final’ version should address is leverage. Do I really want to put 25% of my savings paying down debt if my debt is a small proportion of my assets (low d/e).

Maybe it would be simple enough to add a additional factor where you multiply your d/e (with a max value of 1 or 2) by your dair score so if I have a high proportion of debt to equity I will pay it down even faster, while if my d/e is 0.1, I may not pay any extra towards it (or even seek to increase leverage).

Maybe. I wanted to keep the concept simple. Once I start adding XYZ variables, folks check out. The primary purpose is to give people a framework to pay down debt and invest in order to build their wealth over time.

Your model may apply to typical consumer/salaried employees, but it doesn’t really address those that have their own businesses or own income producing real estate. Debt is a tool we use to generate wealth and cash flow.

I can speak for real estate, where borrowing cheap and fixed rate money, on an income producing property, is a great way to use OPM to build your wealth. Of course your success depends on your talents, controlling leverage, and having reserves for unexpected economic turns. But this approach is entirely different than managing consumer debt.

I am changing my approach on my mortgage this year at renewal. I can make more money investing than aggressively paying down the mortgage. I got it to a point where I am comfortable regardless of where I work. With a 50% pay cut, I would still manage. Based on that, I want to invest more.

I currently pay 2.40% and can probably renew close to that for a couple of years in a early 2015.

Great post. I’m not sure DAIR resonates with me because there’s not rationale for your chart other than your own opinion. Please don’t take that the wrong way, your opinion is in line with mine often, but there’s not math or logic to say that the way you’re balancing debt pay off vs. investments is better than some other allocation – why 55% debt pay off if the interest rate is 5.5%? Why not 60% or 50%? Just because it looks good on a chart doesn’t mean it should be done.

If I’ve learned anything from this post it’s that the general public will latch on to any catchy idea as long as they can remember it. The acronym is cool, the table is completely arbitrary, and everyone loves it. I’d take advantage of that while you can!

One person referred to this as a model and I’d strongly argue that this is not a model. I think you, with your IB background, would also agree.

That said, frameworks that help people organize their actions are gold in the self-help aisle of the book store. I think you’ve got a winning framework, I’d just like to see some math behind the rationale.

Let me turn it around. Share with us your idea of a pay down debt or invest framework with your requirements. Make sure it is easy to understand and follow too with the data I have used from historical interest rates and equity returns.

Sam – Have been passively following your blog for a while and posting my first comment today. I understand that inflation in India is at 7% and hence the saving rate or CD rate in India is at 9%. But in my head I still think its a great, almost risk-free investment. And If an individual is an investor from USA where inflation is less than 2% and if he/she is investing in India at 9% its a good deal. Ofcourse transaction cost and exchange fluctuations do have impact but I give that + or – 1.5%, still its a good deal. Unless I am missing something and which case please enlighten me

All excellent food for thought from nearly every response. I have a question I’d like to propose. Say someone had $40k left on an appraised $77k rental property condo fully rented out and slightly cash flow ($200 month) at 4.8% and their own home at $130k with $91k left on that loan at 3.7%. Neither property will appreciate much at all. This person also had 60k sitting in the bank doing nothing, puts 5% into their 401k and maxs out their Roth yearly at $5500. This person grosses $50k a year. What would the best course of action be? Paying off the condo leaves 20k savings left over plus frees up $500 a month in rent. This full $500 could be then invested and no loan at 4.8 either? Thoughts…

I’ve been reading a few of your articles, and I’m now feeling very sick about my retirement savings. And I’m not seeing many, if any, articles that apply to people that make under $100k/yr. (some of us choose to live in areas of the US in lieu of higher paying jobs.) My husb & I have a combined income of $80k/yr. I am 48 and my husb is 52. I feel like, based on your tables and articles, I’m VERY behind in my retirement saving. We have about $250k saved. We have $150k mortage debt (including 2nd mortgage, which I regret taking on, to help with house repairs/renovations), $10k cc debt (and now my $12k student loan debt for a portion of my MBA degree that I will receive in Dec’15 — no regrets on my degree). I have 8% added to my 401k with 4% match and my husb has 10% added to 401k (no match). I’m trying to pay down our cc debt. I have been increasing my 401k contrib amt by 1-2% for the past couple years, but we just don’t have that much extra funds to spare. Any advice?

Abby, my family is in the same boat as yours re lower income. But we live in a lower cost-of-living area, so there’s some compensation there. For those of us making <$100k, the math is simply a longer and not-as-steep gain curve. That means we simply do everything slower.

Unlike a lot of folks here, I'm not a CFA or work in the Financial sector. But I will say from an emotional stance, that debt is a huge stress burden. That stress isn't something easily calculated into a simple math formula. However, what you wrote suggests you guys are well on your way to where you want to be: Your household is already contribution 18% to retirement (w/o match). You already have a substantial savings.

I'd say try a de-stressor experiment: Take any additional money you have and pay down the highest interest debt while making minimal payments on all others. Just commit your resources to making ONE headache go away. (Personally, I despise credit cards and would target that, but if the cards have an immutable interest rate lower than other debts and no annual fees, choose the highest rate debt first.) It's amazing what removing one bad element of your life can do to your mood. Becomes addictive toward killing off others. The only caveat here is if you don't have a built up emergency fund — do THAT first, even if it's only a couple of month's living expenses, have that buffer in place with sometime simple and cashable like CDs, even with their crappy interest rates.

I don’t understand why you would pay down any debt? I allocate all of my money to my leveraged stock investments in order to take full advantage of compounding interest. I am confused as to why anyone would remove dollars from a compounding interest investment to pay off debt at a very low interest rate.

I wrote about my investing approach here: patientwealth.com/extreme-investing/

Sometimes markets go down and the economy turns bad. Have you been investing since circa 2009 or before? How much money are you investing total? I’ve found my risk tolerance tends to go down the more I accumulate.

For example, let’s say you return 5% on $10 million, that’s $500k, enough to live well. But if you lose 10% on the $10 million, that’s a pretty painful loss.

Have you considered working as an investment professional given your track record? It’s a pretty lucrative business. I know one guy who simply trades a pretty reasonable $3 million portfolio of his own for a living.

FYI: in my 20s I went 4:1 leverage on San Francisco property that turned out OK. Now I’m retired and don’t want to take as much risk.

I appreciate that you religiously remind folks that markets go down. Absolutely true. In the short term. And if one is investing by picking individual stocks, there’s much risk with the potential greater reward by not diversifying. I’d suggest you add in:

Markets can go down (even to $0 in theory). In the short term. The gamble is: will you NEED the money when you are at the trough of a cycle, or somewhere north of it. The fact is, WHEN the market goes down and you need some (or all) of those assets then, you’ll realize a loss rather than just have paper losses. The prudent investor has a spectrum of investments just as Sam has preached in other posts — simple savings like a CD ladder that is cash-available for short to mid-time frame life expense coverage, and a mix of equities/bonds/munis/physical investments in various percentages. Most of us will live long enough to see the far side of whatever recession is on the horizon, and should be coached to think both short and long term.

I like the overall idea, and thanks for offering a broad rule for many to follow. Great post!

One proposed modification:
Shouldn’t the DS FAIR change though based on the risk-free interest rate for investing? If the interest rate on your debts is fixed and the return on investments variable on market conditions, the latter would seem to be an important variable to consider in allocation of capital.

To this end, I’d maybe offer the (interest rate on debt) – (risk free interest rate) * 10 to calculate the new DS FAIR? It does add a new wrinkle, but seems to be more logically consistent to me.

It’s amazing to me that after 6 years in the job market I arrived at a very similar conclusion (50% debt payoff to 50% investing) after taking my company match and tax into account. Managing finances in US is hardcore stuff. Thankfully I’m passionate about finances and economics in general. Thanks for all you do, validated my approach and also enlightened me over the years.

I have a question. If you have a 30 year fixed loan at a very attractive rate 3.1% and you could invest in a 30 year investment grade bond at 4.5%. Would it make sense to invest 100% in the bond to take advantage of the interest rate arbitrage between the two instruments?

I am assuming that you keep the bond ’til maturity and that you bought it at par.

Nice post with plenty of data for minds to chew on. A couple of nits to pick:

First, the Fed didn’t cause the housing bubble of the 2000s. This was a direct effect of the removal of Glass-Steagall by Clinton and the ‘Conservative’ Republicans in the mid-90s along with the loosening (or complete abandonment) of sensible regulation to allow subprime mortgages. It was Congressional and Banking greed, no leadership under the pretense of ‘free markets’, nothing more. The Fed sets the Prime as this excellent blog author has pointed out many times — but the housing bubble was ultimately the voter’s fault for whom they chose, and failed to keep on a tighter leash.

This becomes more complex when the investor moves beyond easy calculations like cash/equity/bond rates and into real estate, but using the mortgage interest + annual property tax hikes can be a suitable substitute to evaluate paying that down.

All of this is predicated on paying at least a little attention to monthly trends, without lettings yourself get caught up into daily micromanaging. If debt makes you emotionally uncomfortable, don’t tolerate it in your life at all. However, economically, it makes more sense to let your more liquid assets work for you if you can profit from the spread between your yields and your obligation costs (debt costs+interest).

[…] version of Financial Samurai. My only innovation is coming up with new financial metrics like FS-DAIR for paying down debt or investing, FS-FR Score for measuring fiscal responsibility, the 1/10th rule […]

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